An E-Mail From the Bull Camp

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I am clearly not wired like a large cohort of investors who clearly have some sway in the markets.

As the popularity of CNBC and attests, for some, the stock market is a form of sport. Actually, better than sports, since in every contest someone wins and someone loses, but over long periods of time, stocks appreciate.

Yet I am dumbfounded at the way the public at large sees equities as safe. As we have pointed out, citing Amar Bhide, equities are a very ambiguous promise: you get dividends if the company shows a profit and management decides to pay some of it out, and you have a vote on certain corporate matters. Both these rights are subject to dilution. I take some comfort from the fact that star investor Peter Lynch once said something along the lines of, “When equities are regarded as safe is when they are most risky, and when they are seen as speculative is when they are the best buy.”

Since I’ve had to analyze deals and companies (starting in the days when spreadsheets were done by hand and you had to read annual reports and extract data from the financials and footnotes, rather than consult pre-calculated ratios prepared on God knows what basis from various services). I regard it as serious work to really understand a company and view markets as frequently irrational. I find the retail investing subculture a bit perplexing. Yes, there are clearly some people who do do the heavy lifting to make informed stock picks, others who use index funds, but there is a large camp that does neither.

And that isn’t to say they aren’t intelligent, but they operate on assumptions that are different than mine. So I wonder whether my reaction is prejudiced, even though my training says not. Or am I merely an old fart and things really are different this time?

Case in point: a buddy who likes the ponies (even calls stocks “the ponies”), bought his first stock at the age of 11, has good insights by virtue of a day job that gives him lots of useful fundamental and company-specific information, and has done pretty well over time (although not so well in this bearish market) regularly argues with me to tell me that my generally dour views are all wet. America is adaptable, we’ll get through this as we have past crises, and there are always good stocks even in bad markets.

He sent me this message today, an exchange with his broker, who he considers to be pretty astute. I’ve reversed the usual forwarded e-mail format; these messages are in chronological order:


Should we dollar average the citi? is it time to start rebuilding or should we wait for the next consumer shoe to drop which will be the credit cards and the 2nd mortgages.


Looks like any weakness now should be bought – Yield curve is positively sloped and that is what I was waiting for . Should see Dow 13500 + …. S&P looks better . Anything though that is done should be done on a
dollar cost average basis….the time has come for me to be a bit more bullish.

You tell me….

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  1. Av

    Off topic, but i thought this was interesting:
    ” The Credit Crisis, Subprime, CDO Managers And Conflicts Of Interest”

    “… A big issue that has been identified in our discussions is the conflicts of interests which are inherent in these structures [CDOs]. Many of these conflicts were recognized and in fact commonly disclosed in the offering memoranda. For example, it would be common for a CDO manager to advise lots of different CDOs in respect to the same collateral pool. That CDO manager might also be receiving fees from the originators of asset backed securities which are then purchased by the CDO manager for his asset pool. And there might be all sorts of cross holdings in terms of directorships and equity holdings.

    These were known conflicts within this industry which were recognized and often disclosed. But there are other conflicts which were not disclosed and arguably were misrepresented. The one that keeps coming up is the situation where the CDO manager was an equity noteholder in the deal. This was actually sold in most instances as a deal benefit; the idea being that if the CDO manager has skin in the game, then he ought to be incentivized to perform to the best of his abilities for the benefit of all noteholders.

    Unfortunately, because of the way the subordination operates if you are an equity noteholder then clearly you are at greatest risk of losing your capital and you are therefore incentivised to carry out a high correlation low diversification investment strategy. That is to say, it is in your interests to put all of your eggs into one basket because that offers you the best possible chance of you getting your money back. The downside to that is that it also increases the likelihood of investment grade noteholders also losing their money. Their interests are best served by a highly diversified investment strategy, so you have immediate tensions built into these deals as a consequence of the manager being an equity noteholder.

    The other aspect to this is, as an equity noteholder, your main interest in the deal is the excess spread, by which I mean that, to the extent the collateral pool can generate income in excess of the liability to pay the coupon on the notes, the excess spread goes to the benefit of the equity noteholders. What that does is to incentivise the manager, as an equity noteholder, to pursue a high yield strategy. The more likely a bond or credit asset is to default the higher the yield or the higher the spread. Increasing the excess spread is in the manager’s interest, but from the investment grade noteholders point of view this was not so great because they were looking for more security and overall asset credit quality.

    What happens as part of the syndication is a process of subordination with the default risk being concentrated on the equity noteholders. The idea is that they act as a buffer with the result that the deal will have to lose a lot of money before it starts affecting the mezzanine noteholders, let alone the AAA investors. However, with the CDO manager incentivized to put all his eggs in one basket and to pursue a high yield strategy this arguably undermined the whole rationale. The interesting thing about conflicts as a legal concept is that they are internationally viewed as a bad thing and that they need to be properly disclosed. Most jurisdictions would recognize that what you are in fact looking for is full disclosure and the informed consent of all contracting parties and that without that there is a possibility the deal can be unwound.”

  2. John

    Reminds me of Jane Bryant Quinn’s quote that “The market timer’s Hall of Fame is an empty room”.

  3. Anonymous

    Dollar cost averaging is one of the stupidest investment strategies ever perpetrated on the American public. No professional trader dollar cost averages. It is the path to trading ruin. Like doubling up continually in blackjack it will work 98% of the time, but the one time it doesn’t, your whole pile of capital is gone.

    When the market tells you that your trading idea is wrong, cut your losses. Never forget – the market is right, you are wrong. You can always put the trade back on later, but you can’t have a clear mind about a trade when you have it on.

    The best traders I know lose money on 60+% of their trades. But they keep those losses small on a per trade basis. When they are right, they ride their winners.

    Dollar cost averaging. Nonsense.

  4. Yves Smith


    That is interesting. Some proposed remedies for securitized credits call for the originator to retain a piece of the deal, usually the equity. I recall thinking, “gee, wasn’t that done a fair bit of the time,” and went on.

    Someone needs to tell the Powers That Be that we tried that one and it didn’t work….

  5. Aaron Krowne

    I had been working on a particular relative of mine for a few years in attempt to get him to see some of the key points of the “market skeptic” perspective I hold.

    Recently, he sent me a bullish “buy the dips” dispatch from his asset manager (for all the worst offenders of the equities of course). This is a serious high net worth management shop.

    He was curious to see what I’d say.

    I spent a few hours going through point by point and completely demolished the report. Totally and utterly, using actual data.

    He was sort of stunned, but soon after told me “I think you are right, or at least, there is something seriously wrong with the market and it is no longer safe; I’m already losing lots of money… but…

    … but I cannot change my ways.”

    Then went on about life just being tough (which I agree with, but it will be tougher if you aren’t adaptable).

    I think there is a lot of this “psychological momentum” effect going on out there, drawing out the reckoning (but not, of course, eliminating it).

  6. Yves Smith


    When I was in Caracas (for a grand total of a day and a half on a project), I heard an expression that seems to epitomize the behavior of your relative:

    They have changed their minds, but they haven’t changed their hearts.

    And I have to commend you for trying….

  7. vlade

    “we’ll get through this as we have past crises”
    Ah, the survivorship bias strikes again…
    Unfortunately, for a wast majority of people out there the best (and only) model of the tomorrow is today (or maybe yesterday, if today wasn’t that great).

  8. Hubert

    Some of these comments are too general.

    If you are not on margin and you really know your stuff you should average down. Problem is, only few qualify. Buffett does, Bill Miller not: swam naked when the tide finally went out.

    On Gartmans rules: One can also bleed to death by getting out of too many trades too early. Gartman can always sell his letter; a trader has to get some trends right.

    All trading rules are interesting but it is everyone for himself: it comes down to psyche, what you really know and how far your mental and financial reserves stretch.

  9. Anonymous

    dollar cost averging, hahahah.

    A good reason to keep trading is that these people will, and they dont know what there doing.

    No good investor averages losers (saying Buffet does is like always talking about Jordan when it comes to Basketball), but even if some do, no (NO!!) good trader does. But there is a second problem here, why is he asking his broker???

    Good luck

  10. S

    Boiler room economy. Think this is bad, imagine being a fly on the wall in a hedge fund morning meeting….downright scary…at least we have Cramer

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